The TFT guide to CPEC for incredibly smart people

It has been a year since President Xi Jinping’s visit to Pakistan to lock down a monumental series of projects between China and Pakistan called the China-Pakistan Economic Corridor (CPEC). Since then, the CPEC silk handshake has garnered near-celebrity status in Pakistan. But despite its popular appeal, CPEC remains least-understood in its entirety, especially because it is mostly viewed in the media through the lens of security risks. Even the political debate has been more controversial than enlightening. So, what is CPEC, anyway?

How long has this been going on?

CPEC has a long history. Talks of a corridor spanning the Chinese border to Pakistan’s deep water ports on the Arabian Sea first started in the 1950s. This was one of the major reasons why construction of the Karakoram Highway was begun in 1959 by China. Similarly, Gwadar was completed by China in 2006. What led to the current form of CPEC was first initiated by General Pervez Musharraf but was postponed due to political instability in Pakistan following the end of Musharraf’s regime. It was again proposed by the subsequent government of the Pakistan Peoples Party and formerly launched during the Pakistan Muslim League-N’s current tenure.

What is a CPEC?

CPEC is a corridor and a collection of projects worth $46 billion. Almost 61% of this will be spent on Pakistan’s energy sector to improve system capacity, transmission and the distribution network. The remaining 39% is for infrastructure, transport and communication. The projects are staggered. The early harvest ones, mostly energy projects, are expected to be done by 2017 and 2018. They are expected to add 10,400MW to the national grid. The remaining projects are divided into short-term (2020), medium-term (2025), and long-term (2030) projects.

The corridor itself has three routes—eastern, central and western—stretching through Pakistan and culminating through one route into China’s western Xinjiang province. The three routes mostly involve realigning Pakistan’s existing road network. So CPEC is both an investment package and an actual corridor at the same time.

What’s in it for us?

Both Pakistan and China stand to benefit from CPEC. However, which side will benefit the most is highly debated. So far, so good. Foreign direct investment (or investment in businesses) under CPEC from China has started coming in mainly in the energy sector. The Chinese and Pakistani governments have paid Rs7.64 billion and Rs1.14 billion, respectively for different infrastructure projects. This means jobs are being created. For example, the Port Qasim power project will create 2,000 new jobs for Pakistani engineers and labourers and 400 trained professionals. The Sahiwal coal power project will employ 3,000 Pakistani and 1,000 Chinese workers. Businesses, especially construction, are already setting up new plants. Lucky Cement has opened a new one in north Punjab in reponse to the high demand for cement for CPEC. But these benefits are coming from the making CPEC. They will funnel out eventually. The long-term benefits of CPEC will show up in other ways.

First off, CPEC investment can help Pakistan with its acute energy crisis by hauling up its production. Right now the energy crisis is costing the economy 2 to 2.5% of GDP, so there is a price to pay. Secondly, the country’s sagging road network will improve markedly. Barring these two, nothing is clear yet as to how CPEC will benefit Pakistan.

The yellow line shows the long route China uses currently for goods. The red route is CPEC.

That isn’t helpful…

Yes, we know. This uncertainty is fuelled largely because of the very nature of the corridor. We are not entirely clear what form it will take. It could be a development corridor, a transit corridor, or an economic corridor. There are concrete facts indicating that CPEC is leaning toward being one of the three.

Experts have said that CPEC would be more of a transit corridor to re-route Chinese exports worth more than $2 billion. This is quite plausible. Chinese exports from its western province of Xinjiang have to otherwise go through 4,000km of Chinese land to reach its eastern shores. From there it is taken to other countries. So naturally China would prefer the shorter more direct CPEC route through Pakistan over its own costly one for exports by Xinjiang province. Pakistan’s payoff matrix in this scenario would then be reduced to providing logistic facilities only. But if CPEC becomes more of a transit route, Pakistan can still leverage its economic gains. One such option is making other countries pay to use the corridor or a transit fee. While the estimate may be speculative, Kashmir Affairs and Gilgit Baltistan Federal Minister Chaudhary Muhammad Barjees Tahir has claimed that CPEC could rake in $70 billion in revenue each year through a transit fee.

Now you’re talking; we can make money?

But there’s a catch to this scenario. A transit corridor would severely limit CPEC’s socio-economic impact on Pakistan at large. This outcome could be reversed if CPEC ends up being a development corridor instead. The development would depend on the geographical nodes of the three CPEC routes. Let’s take the case of each route. The Western route passes through some of the impoverished districts of Balochistan and southern Khyber-Pakhtunkhwa. The Eastern routes move through the deprived districts of southern Punjab and northern Sindh. Districts in these two areas of Punjab and Sindh are a sinkhole of poverty. The Central route also passes through districts in southern Punjab and a few in south-eastern Balochistan.

Politicians of each province have raised concerns about development based on this route. For example, both eastern and central routes touch the south Punjab districts. Only one route each are in Sindh (eastern) and KP (western). The net result of this arrangement may be socially disruptive because rather than promoting inclusive development, this could aggravate an already entrenched political and economic inequality among the provinces. Already there exist serious biases in development spending by provincial governments. For example, Marc-André Franche, the outgoing UNDP chief to Pakistan, has said that as much as 85% of total physical spending in Punjab is given to Lahore alone.

Then there is another angle to CPEC being an economic corridor. The Government of Pakistan has proposed 29 economic zones along each route. China likes the idea. Some of these economic zones are right next to the sites of different projects. These economic zones encourage businesses through incentive schemes like tax holidays and the duty-free import of raw material, and machinery. Earlier this year, each province’s Board of Investment proposed a possible list of CPEC economic zones. As of now, only the ones for KP and Balochistan have been finalized. The government cautions, however, that not all economic zones are necessarily part of CPEC. Pakistan’s experience with economic zones hasn’t been encouraging. In the past, the government has repeatedly withdrawn incentive structures for them.

Should we worry about China?

We need to understand why China is doing CPEC in order to better leverage our position in this bargain. CPEC is part of China’s “One belt, One road (OBOR)” program—an ambitious development strategy that attempts to connect Eurasian economies for trade facilitation through a network of roads. The underlying aim is to reduce travelling required for Chinese exports to Europe, Africa, and the Middle East. Under this initiative, China is building six corridors, of which CPEC is one.

In CPEC’s case, China will be saving $2 billion annually on oil imports by taking the shortest route into western China offered through Gwadar. In line with its OBOR philosophy, CPEC too offers Chinese exports the cheapest route. Exports by China’s western province have to travel 4,000km across China before they reach its eastern port to be shipped to other countries.

The case of Western China is interesting. It is the Balochistan of China in some ways. Its share in total Chinese trade is a mere 5% but it makes up for 70% of the total land mass and 28.8% of the population. Through CPEC, China is fuelling its western front’s development. In Xinjiang province, which is part of CPEC, there are separatist elements headed by the Turkistan Islamic party which promotes terrorism against the Chinese state. By launching development, China has also designs to rid itself of separatist tendencies in Xinjiang. China has already started work on economic zones in the province.

Who foots the bill?

Who is coughing up the $46 billion? The money for all power projects is going to come just like private sector investment. So a large chunk of CPEC money is a non-government flow to the energy projects which take the lion’s share. In some cases, CPEC projects are being run as joint ventures between Pakistani and Chinese companies. Some projects are being built under the build-own-transfer principle. Under this, a project execution authority runs the project until costs are recouped and a certain agreed-upon profit margin is secured. It eventually transfers the ownership to the project-approving authority.

Interestingly, the debt-equity breakdown of most projects is 80:25. This means that companies are investing 25% of their own money while the rest (80%) is being raised by taking loans. Mostly these loans are being taken from Chinese banks such as the Export-Import (Exim) Bank of China in the case of the Port Qasim power project and the Industrial and Commercial Bank of China for the Sahiwal power project. Pakistani banks too are loaning out money. HBL, UBL and Bank Alfalah have lent money for the Engro Thar power project. The infrastructure projects are based on Chinese loans to Pakistani government. The money will be spent through the relevant ministry or department in Pakistan. For example, the National Highway Authority is massively involved in CPEC infrastructure projects.

How will this affect us financially?

The financial arrangement has implications for Pakistan’s debt scenario. Firstly, the direct impact of CPEC on our national debt is limited to $11 billion under infrastructure projects which are government-to-government transfers. Secondly, as for the power projects, there is no direct impact on national debt. But indirectly it could happen. As mentioned above, the debt ratio of most CPEC projects is 80%. So most of the money is debt financed. When payment on these private loans is due, they can put pressure on forex reserves in Pakistan because the repayment is in dollars. Pakistan will be forced to incur more debt to push up forex reserves in this scenario.

Can we handle all this work?

Pakistan has never had any experience with a project the scale of CPEC. This institutional inexperience is showing as well. There is a huge problem of water supplies around Gwadar port, for example. To do something about it, a Rs11.2 billion project was undertaken. But the Gwadar Development Authority is not aware of whether it’s a grant or a loan. If this water issue persists, projects around the port could be disrupted. Then, there are land ownership disputes between the provincial and federal government around project sites. We will have to figure out ways to quickly solve such institutional problems when they crop up.

Will CPEC make Afghanistan happy?

In a recent trade summit of Central Asian republics, Pakistan and Afghanistan in Islamabad, the Afghan ambassador emphasized that CPEC is for Afghanistan as well. His Central Asian counterparts followed suit. As they are landlocked countries, Gwadar provides them the shortest and cheapest route for the import and export of goods as well. Pakistan could become a transit hub for these countries too. Through improved road infrastructure, even India could have access to Central Asian markets. But we’re not holding our breath on that one.

China’s coal has choked its cities. Should we worry?

With opportunities, come risks. And CPEC is no exception. You are right to worry about the environmental impact but it is one of the least-discussed risks, especially to the ecology of Gilgit-Baltistan. Most of the people in GB live around the area of the Karakorum Highway. Further construction and traffic in this region could produce pollutants. There is news suggesting that some forest cover in the region may be lost irrevocably.

And that’s not it. CPEC power projects are mostly coal-based. Despite being the cheapest, coal is environmentally the costliest. It produces high carbon emissions that are a major ingredient of climate change. Through different conventions, the world is moving away from coal-based energy. Once the Chinese are done with it, Pakistan may find it difficult to rope in other foreign operators for these power plants. They may become a fiscal liability.

And the bigger picture?

Once completed, CPEC can make Pakistan increasingly connected to China. Yes, Pakistan will grow as China grows. But if China slows down, so will Pakistan. High connectivity will make us highly vulnerable. We saw what happened to Latin America where China has huge investments.

CPEC tips for parents

Put your kids in Chinese classes, you can thank us later
Pakistan is about to fall into the Chinese orbit of influence because the consensus in the US is that it is not worth America’s effort to keep the alliance going much longer, says Farooq Tirmizi, an investment analyst (see his piece ‘Careful on the kowtow’). “It is unlikely that Pakistan will ever formally be declared an enemy of the United States, but the pretense of an alliance is over, likely permanently,” he writes. “So learning Chinese may be helpful.”

Funnel that college tuition into an engineering degree
Engineering degrees were always a great idea, long before and long after CPEC. Being good at Mathematics can go a long way as well, says Tirmizi. So, if your teenager is starting university you know what to pressure them into doing. Becoming a doctor is so 1989.

Research energy stocks
Aside from learning Chinese and getting your children to become engineers, it may be worth seeing if an energy-rich portfolio can help bankroll it. How well are your conventional energy stocks are doing? Ever considered solar? An expert who was reviewing mutual fund statements for some private banks in Pakistan noted that most of them have energy stocks in their equity portfolios which were giving investors healthy returns.